This week has seen some momentous events for the economy of Europe and in particular for its more peripheral members such as Greece and Portugal and maybe Ireland and Spain too. However today is the day when the UK economy is due to take centre stage in the televised debates and many eyes will be on the BBC to see what the leaders of the three main political parties have to say. Tonight does matter as it would appear that the electorate is rather undecided and is still looking for a real leader to emerge. I have mentioned before in my update on the 15th April that we have had something of a false debate on this subject where none of the main political parties have properly addressed the challenges facing our economy. This is always an important issue but as we struggle to recover from the severe recession of the “credit crunch” and try to avoid any backwash from the current crisis in the Euro it should be the most important issue in the election debate.
Fiscal Policy and “the elephant in the room”
On the 15th April I observed the following
Yesterday Vince Cable the prospective Chancellor for the Liberal Democrats used this evocative phrase to describe the question of the UK fiscal deficit and of course this also has an implied view for the National Debt. However this is an area where all three main political parties have similar flaws in their plans. If you look at the three published manifestoes there is a hole in each of them of a similar size, £30 billion. So in truth none of them are being transparent and honest in their spending pledges. So the answer to the question what are they not telling us? Is in economic terms £30 billion. This is just over 2% of our Gross Domestic Product (GDP). Put another way it is around a quarter of the annual cost of the National Health Service.
Since then we have had little or no further insight from any of the main political parties on what if anything they plan to do. I say if anything because one of the lessons of the crisis surrounding Greece is that Europe’s politicians plainly feel that even such a serious crisis can still be fixed by talk and promises. One cannot dismiss the idea that ours may be doing the same about our fiscal deficit. When Chancellor Merkel of Germany said yesterday that Greece required a “timely” response ,which regular readers will be aware is in fact the opposite of the approach she has adopted as she has been desperate to delay any aid package until after the May 9th elections in North Rhine Westphalia, I was reminded of the song which starts “Reality was once a friend of mine……”
What is the situation?
Our fiscal deficit for the last year was £163 billion which is 11.6% of our economic output (Gross Domestic Product or GDP). A major component of this high level of borrowing was the impact of the recession we have just been through but it is also true that the public finances had deteriorated because of the decision by the current government to increase public spending from 2002 onwards. This deficit is likely to prove persistent over the next few years and current plans still involve us having a fiscal deficit at the end of them in 2018 when for example we will still be borrowing 6% of our economic output. So we are in danger of pushing our national debt and the annual cost of financing it onto an expensive unstable path.
All of the three main parties accept this reality it is just that they have no concrete policies to deal with it. The main problem is public spending plans or rather the lack of them and I am grateful to the Institute of Fiscal Studies for these numbers for the period up to 2014/15.
The worst offender is the Liberal Democrats who have not explained where they will find £79 billion of spending cuts which is 5.4% of national income.The Conservatives plan spending cuts but have not explained where they will find £71 billion of them which is 4.8% of national income. Labour plan spending cuts but have not explained. Labour have £59 billion of spending cuts which they have not explained which is 4.1% of national income.
Conclusion and Comment
There are slight differences between the exact composition of these numbers so they are not be taken too literally but as a group they are very revealing. You see the cuts required are of a scale not seen since the IMF was called into the UK in 1976 and depending how things actually turn out maybe not even then. The scale is enormous and I feel that the reason politicians of all parties are not telling us is that they simply do not know. To that extent all of the manifestoes produced so far are a misrepresentation of our position and this does have a slight echo of what happened in the last Greek election. I do not think we are in the same position as our national debt is lower in comparative terms but this sort of political thinking was one of the contributors to Greece’s current mess and accordingly it would be unwise to repeat it.
I have previously explained the true position of the Conservatives plans for what they call the “jobs tax” for today I wish to just point out the scale of it £6 billion a year and then for you to compare it with our deficit of £163 billion. Our political debate has centred on what is in the main scheme of things a relative sideshow.
Some honesty is needed and I hope that this question will be asked tonight, When will you tell us the truth about our fiscal deficit?
We are in a position where our inflation rate is above target but there is almost no debate about it at all. One possible reason for this is that many members of my profession subscribe to an “output gap” theory and seem to feel that because it predicts that at this time we should not have inflation then in fact we do not ( “Reality was once a friend of mine” again). Those who do not follow this subject closely may be unaware that our inflation target was changed in 2002 to what I consider to be a softer target so that our actual position is in fact worse than shown by the current target. I discussed this subject on the 20th April.
Our Old Target RPIX
RPIX inflation – the all items RPI excluding mortgage interest payments – was 4.8 per cent in March, up from 4.2 per cent in February. Perhaps the most revealing of all the numbers as this was our previous inflation target and was set at 2.5% so it is some 2.3% over its target.
I am not one of those who sees inflation around every corner but I am one of those who has concerns that this phase has the risk that it may persist for longer than the official view of a “blip”. You see the Monetary Policy Committee when it sets interest rates looks 18 months or two years forward. So if we go two years forward our official forecasts are for a high growth rate of 3% per annum and we have inflation in our system before we get this acceleration in growth. Other central banks such as the ECB are already worrying about inflation in the future from much lower inflation levels than ours implying that they would already be responding.
The Monetary Policy Committee (MPC) of the Bank of England
This body was set up by the current administration to set UK interest rates and the point of it was that it was supposed to be independent and therefore not subject to political interference. This was successful for the first stage of its existence but the advent of Quantitative Easing means that it can no longer claim to be independent of government policy in my view. You see this policy required the permission of the Chancellor of the Exchequer and tied monetary policy to an extent with fiscal policy.
This subject has had no debate at all during the election but my question for tonight would be twofold on this subject
1. How do you plan to make the MPC independent again?
2. What reforms do you intend to make to the MPC to help prevent it making more policy errors in future?
This was a policy undertaken by the Bank of England where it purchased some £200 billion of our own government debt starting in March 2009 and ending in February this year.It’s stated policy objective at the time was that such a policy was required to bring inflation back to its targeted level. You can see from my section on inflation above what it actually helped lead too. Since then the Monetary Policy Committee has changed its view on what the policy was supposed to achieve more than a few times. If you read my articles on this subject you will see my explanation of why i feel the policy was a mistake and certainly should not be extended in any way. But today I wish to firstly point out the lack of any debate on this important subject in our election and explain the implications of what has already happened for the UK’s economic future. I explained my thoughts on the 1st of April.
QE was a policy mistake which has implications going forward. In effect the Monetary Policy Committee acted like an organisation in a state of panic. Perhaps the first tranche can be forgiven as a mistake in extraordinary circumstances but to continue with it was a clear error in my view. As I have stated above there was evidence prior to the event of the likely consequences of it.
Going forward there are two other problems. The first is that one day we will have to get these bonds off the books of the Bank of England. The other is that the asset bubbles which it has helped to create are reinforcing some of the problems that created the credit crunch. Whilst it is painful we do need an adjustment in areas such as residential property and I see no reason at all why we should protect wealth created by the speculation and bubbles of the pre credit crunch era. If you think about it doing such a thing is likely to slow structural reform for our economy and we badly need structural reform in my view.
So a policy which was supposed to boost economic growth may end up contributing to medium/long-term growth actually being lower than otherwise as its effects filter out. And it makes us more vulnerable to future economic shocks.
If one looks at a Marxist type of analysis of this policy one might conclude that it looks like a way of protecting an already wealthy elite who are likely to be asset rich which is wearing the clothes of claiming that it protects everyone by suggesting that all falls in asset prices are bad….
A reinforcing number for my arguments above has been issued this morning by the Nationwide Building Society. According to the Nationwide house prices have risen over the last year by 10.5%. Now let us look at our economy, we have high and possibly rising unemployment, real wages are falling,and credit is still restricted and constrained. Then so far in the house price recovery we have had fewer actual transactions than normal. This to my mind is a “bubble” and leads to another question for tonight.
What would you do about the current house price bubble and how much do you think official policy has contributed to it?
Let me make it clear that I do not wish for home owners to lose money but that having gone through a deep recession it is to say the least curious that we appear to have rising house prices and from the point of view of prospective buyers they must now be even more expensive than they were in 2007. It may even be true that in the wealthier areas of London prices exceed 2007 levels…
The standard of debate on economic matters in the UK election so far has at best been poor. This is not unprecedented in our history as 1992 and Harold Wilsons first administration come to mind. However I have outlined what I feel are important issues and hope that someone in the audience tonight will be thinking along similar lines or will read them today.
I was asked yesterday to relate what is happening in Greece to what is happening in the UK and hope that I have left you with the opinion that we are not Greece but we do have serious issues many of which are not getting much of a public airing. We need to address them to try to keep us out of the financial whirlwind which is surrounding Greece as if we dither and misrepresent as our politicians are doing right now then we could get sucked into trouble. Perhaps as a final question for tonight someone might like to ask a (slightly mischievous) question, do you think the UK should join the Euro as it presently stands? You see over the next few years whatever your stance on the Euro (and by this I mean for or against) exchange rate flexibility looks like it could be a valuable weapon.
I am now off to look at some genuinely scary rumours coming out of Greece that for example a rise in Value Added Tax to 25% is bein proposed…